Will Europe retaliate for Congress’s proposed electric vehicle tax credits? Don’t bet against it

Congress is getting an earful these days from America’s trade partners about the tax credits it is proposing on electric vehicles (EVs).

The complaint is that these tax credits, as written, are biased against imports, and run afoul of global trade rules. Canada and Mexico, for example, are talking about challenging the tax credits at the U.S.-Mexico-Canada Agreement (USMCA). Others, including Korea and Japan, say they might file disputes at the World Trade Organization (WTO). Last week, the European Union (EU) wrote to Senate leadership that, unless rewritten, the EV tax credits “will result in unjustified discrimination” against European cars and car parts. This letter is a game-changer, because the EU is credibly poised to retaliate.

First things first. As I’ve recently written, the tax credits come in at $12,500 per vehicle, but with protectionist fine print. The House’s Build Back Better proposes that $4,500 of this be contingent on the car being made by unionized labor, and that another $500 go to EVs with at least 50 percent U.S. content by value and have a U.S. battery. The full $12,500 tax credit would require both by 2027. The Senate’s version ties $2,500 to final assembly being done by unionized labor, and another $2,500 if the manufacturing facility is located in the US. By 2026, however, the full tax credit would require that both boxes be checked.

The surprise is not that Congress wrote the EV tax credits to favor local content. Other countries are doing this too. Canada, for example, got in trouble for a “feed-in tariff” that the government of Ontario premised on the use of local content as well, drawing the ire of Japan, and a big loss at the WTO.  

Rather, the surprise is that there’s nothing even remotely subtle about the terms of the proposed EV tax credits. Sure, clean energy, as industrial policy, is a politically potent drink, but these provisions are amateurish.

The U.S. has no choice but to work out something with Canada and Mexico because none of President Biden’s EV goals can be realized without these countries lending a hand. Japan and Korea, as well as other countries, could win at the WTO, but an appeal would leave the ruling in legal limbo, given that the U.S. is blocking the Appellate Body (AB). Europe, however, has several unique cards to play.

First, the EU has a unilateral stick for just such an occasion. It’s Regulation 2021/167, and it paves the way for Europe to “expeditiously suspend concessions,” i.e., retaliate, while the AB isn’t functioning. Moreover, the text provides for cross-retaliation, meaning that, in response to Congress’s EV tax credits, the EU could hit back against U.S. services and intellectual property. By design, the WTO would be loath to authorize this.

Second, the EU has a nuclear option: challenge USMCA at the WTO. Back in 2019, the EU entertained the idea of going to the WTO and arguing that USMCA was, by virtue of its “rules of origin” on cars, more trade-restrictive than the North American Free Trade Agreement (NAFTA). That’s because USMCA makes tariff-free treatment contingent on 75 percent North American content by value, up from 62.5 percent under NAFTA, which in turn makes it less likely that manufacturers are going to source parts from Europe. The EV tax credits would only make things worse, and might push Brussels over the edge. As for following through on a ruling, see EU Regulation 2021/167.

The U.S. needs to make lemonade out of these EV tax credit lemons. U.S. exporters of EVs will be on the losing side of similar incentives abroad. Either as part of a bigger push under the WTO’s Environmental Goods Agreement, or separately, EV tax credits should be disciplined on a global basis. 

Marc L. Busch is the Karl F. Landegger Professor of International Business Diplomacy at the Walsh School of Foreign Service at Georgetown University. Follow him on Twitter @marclbusch.